When all else is equal, consumers generally opt for the lesser-priced roduct. That’s the basis of the cost-leader strategy, which relies on decreasing costs enough to secure profits even while prices are lower than competitors' prices. The strategy has several advantages, but it is difficult to pull off, especially for small businesses.

Competitive Edge

Establishing a competitive edge is the primary advantage of adopting the cost-leader strategy. For example, a bakery that sells cakes at half the price of its competitors can dominate its market. The downside is that drastically cutting costs is not an easy task. The bakery might need to lower the quality of its ingredients, slash advertising budgets and pay its workers less, for example. Corresponding negative effects might include lower-quality products, fewer customers reached through advertising and decreased employee retention.

Frugal Company Culture

Lowering the price of inputs is a common way to decrease costs, so a potential advantage of following a cost-leader strategy is the development of a frugal corporate culture. For example, if the bakery can achieve a balance between lowering costs and preserving quality, the frugal culture that results will be a permanent advantage: The company’s cost-saving expertise will always help it charge less while making profits similar to those of competitors.

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Economies of Scale

Another potential advantage is the development of economies of scale. Developing economies of scale refers to how businesses can optimize profits by scaling up their operations while pursuing greater efficiency. For example, suppose the bakery must pay $1,000 a month to rent its building. Whether the bakery produces a hundred cakes or a thousand, the cost of rent remains the same. But at higher sales levels, the profit-to-rent ratio is higher. In other words, the cost of rent is proportionally less if the bakery can achieve higher productivity. Economies of scale in the area of distribution logistics, for example, are how big-box retailers can charge lower prices than small retail businesses. While small businesses might not be able to compete with the high levels of efficiency that large companies achieve, they can use economies of scale to out-compete other small businesses.

Effect

Cost leaders can draw upon many techniques to lower costs, each of which might result in a specific advantage. Generally, the overall effect of pursuing a cost-leader strategy is the creation of a company culture that continually pursues greater efficiency, which is in itself a significant competitive advantage. In contrast, focusing on factors other than cost might cause a company to ignore inefficiencies, such as inflating costs, wasteful practices and under-trained but overpaid workers.

References

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About the Author

Stan Mack is a business writer specializing in finance, business ethics and human resources. His work has appeared in the online editions of the "Houston Chronicle" and "USA Today," among other outlets. Mack studied philosophy and economics at the University of Memphis.